Option Trade Of The Week Gold To Make A Comeback!

Wednesday, 13th May, 2015

The option trade of the week looks at the prospect that gold has been on a downer for quite a period of time and is now set to make a comeback – particularly, certain mining companies that are prepared for this situation. Since gold peaked in 2011 it has been in a decline fairly consistently over the past few years, but gold stocks have also fallen drastically, but at twice the pace – for example, Market Vectors Gold Miners ETF (NYSEARCA: GDX) is now down about 70% since 2011.

Since the last week of March gold prices have been ranging between $1,180 and $1,120; and the rise that has been experienced lately has been due to the depreciating dollar. This means that the weak dollar may help drive the gold prices to the nearest resistance of $1,225 per ounce – which was last seen in March and April, this year.

SOURCE: GOLDPRICE

Other factors that will support the price increase of gold, such as seasonal buying activity – notably India-- will add to Friday’s gold price increase. Gold edged higher, snapping two days of losses, as revisions to US payrolls data supported speculation that the Federal Reserve may hold off raising interest rates in the immediate future.

Reasons for Gold Price Increase

1. Natural Elements – bullion prices have fallen in the previous two months, due partly to expectations that the U.S. economy would be able to rebound from a harsh winter – resulting in a demand cut for the metal as a haven.

2. Fed Rate Hikes -- due to very weak U.S. data in Q1 the timing of Fed rate hikes have been pushed out; market consensus is now for
September at the earliest – which means that the dollar bull has become complacent, as the dollar move has been negated to a certain extent.

In addition, underlying inflationary pressures are nonexistent, and the debt overhang means the savings rate will remain high and credit growth will be slow; so overall growth will also be slow. Add that to the fact there is ample excess capacity in the U.S. labor market, and you get a scenario where the rate hike cycle will be a very slow, careful, and drawn out process.

3. Bond Yields -- real bond yields continue to be suppressed by weak economic growth and central bank policies. Aggressive monetary easing by the ECB and BoJ are likely to continue to suppress and drive real yields lower. Given the link between the gold price and real yields this should mean higher gold prices. Gold arguably offers better risk hedging properties than sovereign bonds at this point.

4. Negative Sentiment/ Options Trading
Decline – traders seem to have interest in gold as price declines have weighed on investor confidence. This is obvious looking at the option trading scenario where investors are pulling out of bets on a rally. Three of the top four options contracts in New York with the most volume on Thursday were calls that slumped at least 60 percent.
These points give a too pessimistic view regarding gold – providing conditions that are now ripe for a rally in gold and gold stocks.

5. Bullish Aspect Comparison – On-the-other-hand, holdings in exchange-traded funds backed by gold are rebounding, and speculators are getting more bullish. The metal has gained 4.5 percent from this year’s low in March as investors weigh expectations for higher consumer costs against signs that the Federal Reserve is getting closer to raising interest rates.

6. Demand Drivers -- Industry experts suggest that the physical demand for gold rises as gold’s price hovers below $1,180 per ounce,
as psychologically, the range $1,180–$1,200 per ounce levels are very important for gold traders, jewelers, and distributors.

India is the second largest gold consumer after China. Gold demand in India increased due to demand from retailers and seasonal buying activity.

7. Energy Inflation – the increase in energy prices will increase the energy inflation which will support gold prices because it’s used as a hedge against inflation. Higher energy costs add to speculation that U.S. inflation will start to pick up, reviving demand for the precious metal as a store of value.

8. Inflation Returning? – In December many investors were unloading gold and bracing for deflation, but are now stepping up bets that inflation is returning. Crude oil in New York rose above $60 a barrel for the first time since December. In April, the price soared 25 percent, the most since May 2009, on signs the U.S. supply glut is easing.

9. Paper Speculators Influence -- Paper speculators in the gold futures market have been a more
important factor in determining the movement of the gold price this year than has physical demand from gold consumers – which can lead to a higher gold price.

It appears that the U.S. Federal Reserve is set to go later and slower on interest rate hikes (as opposed to market expectations of sooner and faster); the bullish U.S. dollar market is set to likewise take a long pause; and at the same time real yields remain suppressed and are likely to continue to be held down, if not fall. The result of this combined with the factors above means that gold will experience one headwind disappearing and a tailwind forming. At the same time sentiment is too pessimistic on gold, which sets the scene for a gold rally. The fact also remains, that gold retains its risk hedging properties; probably more so than sovereign bonds.

Conclusion

Gold stocks are probably the best way to play this
situation as they have been disproportionately punished due to lower and falling gold prices. High-quality gold mining companies have positioned themselves well during this current downturn in the gold market -- with very little debt on their balance sheets, low operating costs, good management, cheap relative to the quality of its assets, its cash-flow generative and some of the best assets in the world.

The patterns on gold charts remain choppy-but-flat trading ranges, and when viewed with a long-term eye, the trend is officially still to the downside. Investors have become blindsided by recent strength in select gold mining stocks, especially since it is not sector-wide. Only the largest by market capitalization are racking up big gains, far outstripping the performance of popular gold mining indices and exchange-traded funds.

But, one looks ready to break out from a double-bottom pattern that has been in development since October.

Find
out which one, by buying this option trade of the day to receive the recommendation for a call option that could make you 50% - 100% gains or more.

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